Fed steps up newly issued debt buys, stimulus drains supply

Aug. 15 (Bloomberg) -- The Federal Reserve has been accelerating purchases of more newly issued Treasuries as part of its maturity-extension program while primary dealers’ willingness to offer securities to the central bank ebbs.

For the first time, the Fed bought the so-called on-the-run, or most actively traded, 10-year note last month as part of its Operation Twist program. It purchased $667 million of the benchmark 10-year on July 18, followed by $1.57 billion on July 25 and $1.85 billion on Aug. 6.

The 21 primary dealers submitted offers equaling $2.22 for each $1 of the securities bought by the Fed in yesterday’s debt purchases, compared with an average of $2.8 in offers this year. The Fed’s Operation Twist followed buying $2.3 trillion of mortgage and Treasury debt from 2008 to 2011 in two rounds of so-called quantitative easing, or QE, while Treasury yields reached record lows in July.

“The Fed purchases have been moving further and further into recently issued bonds in different maturity sectors,” said Scott Sherman, an interest-rate strategist at Credit Suisse Group AG in New York, in an interview. “It’s a signal that the central bank is consuming the inventory out there that people hold and are willing to sell in old off-the-run issues. The Fed therefore is going to have to buy where there is supply that people are willing to get rid of. And recently issued bonds fit that description.”

Monetary Policy

The Fed is purchasing Treasuries as part of its effort to support the economy by swapping $667 billion of short-term debt with longer-term securities to lengthen the average maturity of its holdings, an action dubbed Operation Twist.

The central bank sold $7.8 billion in Treasuries today with a maturity range of February 2014 through August 2014 as part of Operation Twist. The Fed is scheduled to purchase between $1.5 and $2 billion in bonds maturing from February 2036 through August 2042 tomorrow.

The Fed owns its self-imposed upper limit of 70 percent of the total outstanding of seven notes that have maturity dates between 2020 and 2022 in its System Open Market Account, or SOMA, as of Aug. 8, according to data on the Fed Bank of New York’s website. In the 10- to 20-year maturity sector, the central bank overall owns 34 percent of the amount outstanding, according to Barclays Plc.

With the Fed owning more than 50 percent of the outstanding amount of many off-the-run notes, holders are becoming less willing to sell and this may eventually affect liquidity, Sherman said. When there are fewer securities in the open market to buy and sell it can affect liquidity by increasing the spread between the bid and offered prices, making it more difficult to purchase or sell large quantities.